Friday, October 28, 2011

The Case for Capitalism

There are a lot of people who think that our economy is a capitalist economy, that bailouts and bubbles bursting, and out of control corporate spending in elections is all a by-product of capitalism. My impulse is to dismiss these people as morons. I should be nice, so instead I'll try to explain the errors of their ways.

First let us start by pointing out that our economy is very much a "planned economy." Interest rates are artificially set, prices are artificially set or influenced through financial incentives from the government, subsidization, and setting upper limitations on production to set the supply. Then you have government encouraging transfers of wealth through the so called "broken window" theory. I'll go into all of these in more detail later in the article, but these are the ways in which our Government (and corporations that encourage these actions) attempt to manipulate or direct the economy.

Please keep in mind one thing as we progress through this analysis. Just because a corporation encourages something, doesn't make it a capitalist principle. Corporations are looking out for their own interests, but instead of doing it through competition, they like to partner with government to do it through mandate. This is a very critical concept. Without government interference corporations would be forced to compete. Corporations aren't out to compete, they're out to make money. It's not about the thrill of the game.

Doesn't this just mean that we shouldn't allow corporations to petition the government? Where does this stop? A corporation is simply an association of PEOPLE. Would you stop unions, churches, community groups? These are all associations of people. What about families? Yet another voluntary association of people gathered together around a common cause.

If we learned anything from prohibition it's that there will always be a way to get supply and demand to meet. You may make alcohol illegal, but the people that want it and the people that want to make money off of those people will somehow get together. If you make corporate influence in government illegal, you don't make the problem go away, you make them find other ways of forming this market. So long as government has the POWER to give corporations what they want (an advantage over competition so that they can make the most money), then corporations will find a way to get politicians what they want which is more power.

Interest Rates

Interest rates are a price. They are the price given for the use of a commodity (money) over a period of time. The price is or should be determined by a combination of risk weighed with the opportunity of investing this money in another venture. A free market relies on prices as a piece of information that can be used to determine how to invest, what to buy, what to build, what to sell, and when to do all of these things. When prices are set by the government or by government collusion with private parties, then this sends a false signal to other market participants to act imprudently. Even when you know the signals are fake, when real prices are suppressed for false signals you can either go along or get out of business.

Economic law says that as an economy rises, prices drop. Here's how this works. Product A is popular and selling well. Company A makes a lot of money with Product A. Company B notices and they build their own version of Product A and sell it. Company C also builds a version of Product A. Now we have competition. Company's A, B, and C want people to buy their Product A. In order to do that they must compete on quality, price, service, and availability. The more people competing the better it is for consumers because companies will continue to be the best on all of these things. This is why prices always go down.

Now, let's think about what happens with our economy. Our economic improvement, for the past 40 years has begun with the Federal Reserve lowering interest rates. This lowers the price on time and money. This encourages people to buy rather than save by reducing the value of saving. As more money is spent the economy rises, then, instead of lowering prices, the federal reserve says it must RAISE interest rates in order to combat INFLATION. Inflation is rising prices. This should be antithetical. However, when the entire situation is built on the initial lie of lower interest you do not get promised results.

More Government Price Fixing

Don't forget, interest rates are prices, but they are not the only price set by a central body or the Government. By setting production limits on certain commodities, subsidizing lower production of others Government can and does set prices. This again, induces behavior that the government seeks, but sends false signals to the market and encourages often wasteful and imprudent behavior. For example, government sudsidies that encouraged people to destroy crops or let farmland sit fallow in exchange for free money from the government? This is waste. This artificially raises the prices of agricultural commodities under the mistaken belief that it is good for farmers. Farmers have since built their businesses and lifestyles around agricultural subsidies. Removing them now will have a profound effect on their profits. These negative effects are the direct result of government interference in the market and corporate and individual reliance on it.

Another way that government likes to control prices is by adding taxes to the purchase of a product. They do this for several reasons. One is to raise revenues. Sometimes these revenues are rational related such as fuel surcharges to fund highway projects. Other times they are not, such as an excise tax on phone bills that were originally used to fund the Spanish American War. (Coincidentally, these taxes remained for 108 years after their original passage) The other reason the government might tax a product is to drive up the cost and down the demand for a product in favor of a competing technology.

Let's pause here to re-visit the idea of competition. Earlier we talked about 3 companies building 1 product and competing. That isn't always the case. Often times those 3 companies will have 3 separate and distinct products or product methods that must compete on price, availability, quality and service. These companies must then continue to innovate not just on these methods, but also on their individual products to make them better and more attractive.

Back to government interference. When government places a tax on one product in order to help another product you do a number of things. The first is you encourage consumption of an inefficient product. You actively discourage the consumption of an efficient product. You penalize a person who has built a product that is both effective and wins on price. This discourages them from trying as hard. On the other side, you've taken away the competitions incentive to lower prices or innovate to build a more competitive product.

The Broken Window Lie

Many in our government think that you can create wealth by destroying old things. In their mind this creates wealth because you must buy new things to replace the broken things. This fallacy originates with the idea that if you break a window in someone's house, they will have to take money that is not in productive use (in savings) and buy a window and let's say this costs $100. That employs window makers. They will have to hire a window installer and let's say this costs $100 as well. That employs window installers. Now, the original window owner has $200 less than before and all they have to show for it is a window that they previously owned. Does this create any new wealth? Actually, no. It destroys wealth.

A few years ago our government passed a program that said if you let us destroy your old car, we'll give you a grant to help you buy a new car. This was just a bigger example of the broken window lie. In this case bigger meant more destructive. Wealth, meaning assets, were destroyed in the form of cars being compacted and sold as scrap metal. In exchange consumers got newer cars, most of which were financed. The population as a whole financed this through taxation, inflation, and promises of future taxation (ie, government debt).

This highlights the main problem with the broken window. No wealth is created, some wealth is actually destroyed and the rest is merely TRANSFERRED. The window owner transfers $200 and gets nothing that he didn't already have to begin with. The car owner started with a car and now has a car, new debt, and new taxes. The beneficiaries in both of these examples are the businesses that government chooses to favor. Unfortuantely, government can't favor anyone with their own money. They have to do this with other people's money.

How is Capitalism Different?

People think that capitalism is all about government getting out of the way and not regulating businesses. This is only half of the story. Capitalism is when government stays out of the way and neither helps nor hinders businesses. Instead, it sets the field in which businesses compete.

Quick aside. I'm sure, like most people, you've heard the saying "even playing field." Some people thinks this means that government should step in to help weaker players to make them more even with their competitors. Can you imagine this in sports? The fastest wide receivers has to have his ankles tied together so he can't run as fast as his defenders. The tallest basketball player has to play from his knees? An even playing field simply means that each participant in the market is neither favored nor hindered by officialdom any more or less than any other participant. Advantages that individuals work out for themselves are completely acceptable.

In capitalism different businesses would have competed to try to entice the window owner to spend his $200. Car manufacturers would have competed to try to convince people to upgrade their car. In capitalism businesses would decide for themselves based on real market indicators how much to produce at a given price and consumers could decide how best to spend or save their money at a given price or interest rate.

I cringe when I hear capitalism criticized for the government conditioned excesses of the past several decades. I cringe when people say that corporations are capitalistic simply because they are "in business." The sad truth is that many businesses would happily see our society in socialism, so long as they got to direct the spending their way. And usually it is only when they do not get to direct the spending that they rise up and denounce the evils of socialism and corporatism.

Let us instead rise up and demand the level playing field, let us demand that each person be allowed to compete to the best of their abilities without the help or hindrance of the State. Let us demand that government get out of business and remove the product that business would buy from the government. Let us not demand that government unleash our potential, but instead demand that they get out of the way so we can unleash our own damned potential. Let us demand that freedom that has been too long denied to us.